My London Briefing on the Goings On In the South China Sea
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My London Briefing on the Goings On In the South China Sea

by | published October 30th, 2019

I am now well into an important series of six private meetings here in London that are redefining the dimensions of energy investment strategies worldwide.

Despite the changes in global perspective and the tides of international events, the city has remained the primary location to go for development of energy finance. On this trip, the scope of my sessions encompasses the following:

  • Implications from Brexit (now, as of a Parliamentary decision yesterday delayed by the first December British general election in a century)…
  • Prospects from some major renewable energy initiatives in North Africa…
  • Expanding questions surrounding an Initial Placement Offer (IPO) for a minority position in Saudi oil giant Aramco…
  • The Baltic attempt to diversify energy sourcing away from Russia…
  • An attempt to determine risk factors amidst rising Persian Gulf tensions, and…
  • My briefing on the South China Sea (SCS) crisis.

I will have more to say on the first five in various forthcoming analyses and alerts both here and in my premium subscriptions.

But today I want to bring you up to date on that last point – the SCS situation.

As with the meeting on the Persian Gulf, the briefing was held at 1 Paternoster Square (the building on the left in the photo below), directly across from the London Stock Exchange and in the very shadow of St. Paul’s Cathedral.

The assembly – including energy finance folks, lawyers, company execs, government policy officials, and representatives of various countries – was primarily interested in receiving advice on how the crisis would affect oil and other shipping rights.

Answers would have a rather direct impact on crude oil transport pricing and, in some cases, likely availability period.

It is also going to provide us with some interesting investment moves moving forward (so stay tuned for information on that).

Well, the following is an attenuated version of what I said, along with a few of the slides I used…

When China Claims Something They Really Claim It

The SCS crisis involves a tense disagreement over control of sea lanes essential to a huge amount of trade. It pits China against other littoral states (Vietnam, Malaysia, Indonesia, Brunei, Taiwan, and the Philippines) with the strategic interests of the U.S. thrown into the stew for added seasoning.

In the mid-nineteenth century, China drew what became known as the nine-dash line, which claimed virtually all the SCS as its offshore territory. Every Chinese government since has maintained that claim.

Meanwhile, collisions of Chinese and U.S. naval vessels are of great concern, while Chinese interventions in the offshore exclusive economic zones (EEZs) of other states bordering the SCS have heightened the atmosphere.

In London, I divided my comments into two main parts relating to the energy market – oil/natural gas production and shipping/transport – with geopolitical implications as an additional undergirding factor permeating the briefing.

The Staggering Amount of Resources Flowing Through the SCS

There has been much speculation over how much additional oil and gas would result from increased SCS drilling.

The U.S. Energy Information Administration (EIA) issued some rough estimates, but has yet to release a public update of those figures. There is a beta version of the new projections that I have reviewed and commented upon, but there is additional work that needs to be done there before they can have any genuine use.

According to its 2011 projections, the EIA estimated that there are 11 billion barrels (bbl) of oil and 190 trillion cubic feet (tcf) of natural gas of proved, probable, possible (PPP) reserves in the South China Sea. Other sources have suggested significantly less, with ranges provided by the United States Geological Survey (USGS) of little help (5-22 bbl; 70-290 tcf).

Given that there has been little blue (deep) water development beyond the shallower EEZ coastline drilling, little tangible evidence is available upon which to base any concerted projections.

My view is that there is more natural gas than crude oil found from wells drilled further out, and colleagues at China National Offshore Oil Co. (CNOOC) and Petrovietnam (PVN) currently share that opinion.

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The wealth this device could bring in is a potential $3.9 trillion, and you could get on the action.

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The primary issue now is the extent to which the SCS conflict impedes oil and liquefied natural gas (LNG) transport. Here, the determination of realistic risk factors in shipping and insurance are vital to the energy flow.

SCS encompasses shipping lanes that involve a huge amount of that flow.

As of January 2017 (the most recent reliable figures available), 30% of all global maritime crude oil trade passes via the (SCS) – at least 15 million barrels daily. The totals involve 80% of aggregate Chinese, Japanese, and South Korean crude oil imports (more than 90% for Japan and South Korea), primarily in the shipping lanes between the Spratly and Paracel Islands (the locations of major territorial disagreements).

More than 90% of total SCS oil consignments move through the Strait of Malacca between Indonesia and Malaysia, passing by Singapore. The total annualized market value of all – energy and other – SCS pass-through trading volume in both directions is in excess of $5.4 trillion. About $1.3 trillion of that is U.S. trade.

And therein lies the problem.

More than Mischief on Mischief Reef

Increasing Chinese pressure has resulted in confrontations with both Philippine and Vietnamese offshore operations.

Intersecting the former in the eastern Spratly Islands resulted in an international court determination against the Chinese claim. However, that decision cannot be enforced since Beijing and Taipei (the capital of Taiwan) have rejected the findings.

The latest situation between China and Vietnam involved the Chinese Haiyang Dizhi 8 seismic testing vessel and its naval escorts sailing into the Vietnamese EEZ and up the central coast of the country before departing a few days ago. Beijing had earlier threatened military action unless Hanoi immediately stopped construction at offshore locations.

What heightens concern is Chinese construction of forward military bases either on existing islands or creating artificial ones. There are 32 of at least 42 of these installations now under U.S. military reconnaissance. Pictured below are two of them, both in the Spratly Islands. The first is Duan Dang (“Fiery Island”) in the western area closer to Vietnam. The second is Panganiban Reef (“Mischief Reef”) in the eastern Spratlys facing Philippine waters.

Fiery Island is an air force base; Panganiban is for naval forces.

Parsing reality from the political hype permeating the discussion, these are support bases. There are only very limited options to use such locations. They are designed to provide support, thereby allowing the Chinese to extend a physical presence in a wider SCS area. Should any attacks come, they would be launched from the mainland.

However, China is playing a long game here (after all, their nine-dash line has been around for some 150 years). And Beijing is also limited because it is also dependent on SCS trading routes. The slide below indicates the SCS oil trade participants.

Since these figures are at least three years old, they do not reflect the more recent rise in U.S. exports of both crude oil/refined oil products and LNG. The curious 3% figure for U.S. imports involves crude from regional locations under broader company contracts.

Notice that, despite new oil pipeline agreements and a continuing drive to develop domestic oil and gas sources, China is also heavily dependent on importing product across SCS routes. That means its own market needs will temper how far it is prepared to go in ramping up the conflict.

Most of my contacts in the region believe we are moving into a period allowing some movement on regional bilateral and multilateral agreements.

The wildcard remains intensifying acrimony between China and the U.S.

All That and No Sushi

As I remarked toward the end of my briefing, if you put enough heavyweight military ordinance in a confined space, there is an irritating increase in misapprehension and accident. This certainly is a major factor in the Persian Gulf discussions I am having here in London as well (more on that another time).

And then there is the occasional intended military muscle statement.

The slide below is from an event that occurred recently. It is a private photograph taken after a type 094 (NATO designated Jin Class) latest series Chinese boomer (ballistic missile submarine), surfaced in the middle of a Vietnamese fishing fleet!

I doubt they were interested in buying some sushi for lunch.

On the SCS situation and related matters, I will have some major announcements shortly. So, stay tuned.

Sincerely,

Kent

P.S. As you just read, the South China Sea is a hotbed for geopolitical tensions, but not just regarding its throughput volume. See, China has never been shy about its military threats, particularly when it comes to its nine-dash line, which as I mentioned, is their claim to essentially all of the territory in the area. Any presence in the area – particularly the U.S. – is regarded as trespassing. As many signs on this side of the pond indicate, trespassers will be shot, and that’s exactly what China has in mind – with a powerful missile aimed right at U.S. Navy ships. Click here to learn more about this volatile situation.

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